Cryptocurrencies aren’t grabbing the headlines anymore, but overall, these markets have stabilized, and the industry’s strongest competitors continue to invest in the space. This year should see some significant developments in the regulation of crypto, as the litigation between Ripple and the U.S. Securities and Exchange Commission ends.
In the meantime, industry participants continue to struggle with a lack of clear regulation in the United States. Despite the SEC's claims that most cryptocurrencies are securities, the Commission has not established clear rules and regulations in this space. Rather, it has focused on regulation by enforcement, a commonly used claim against the SEC that is, in this case, valid.
Because there is no global consensus on crypto regulation, industry participants face extreme regulatory and financial uncertainty. This uncertainty is changing the financial landscape of crypto, as the U.S. has recently lost its position as the largest region for crypto investments (as measured by total venture capital (“VC”)investment in the space). The winner: the European Union/United Kingdom.
Axios Crypto reports, as of Q1 2023, that the EU/UK is now the largest region for crypto VC investment, more than doubling the level of U.S. investment. We also see Dubai entering the list as the fourth largest region for such investment, following the US and Hong Kong/Singapore, respectively. Regulation is the primary driver of this shift.
In addition to venture capital funding, Bitcoin miners such as U.S.-based Bit Digital are moving their operations overseas to avoid a tax crackdown, as reported by the Wall Street Journal. China was the largest bitcoin mining country in the world until 2020 when it cracked down on local miners. China was attractive to miners because of its cheap, coal-based energy infrastructure. But the communist-controlled country was worried that a decentralized currency could weaken its political control over monetary and fiscal policy. As Chinese miners shut down or relocated their operations, U.S. miners filled the void and even accepted some of the formerly Chinese-based machines. Cheap energy states like Texas benefitted from the migration, as did Russia and Kazakhstan. Ohio, Wyoming, and New York also built massive mining centers that leveraged sustainable energy sources to make mining more efficient and less energy intensive. Now, U.S. regulatory uncertainty is causing a second wave of miner migration.
Like the venture capital trend, regulatory developments are leading crypto innovators to move to Europe, not the U.S. or China. To understand how regulatory uncertainty in the U.S. and smart policy in Europe are driving this second wave of migration, let’s review the current regulatory state in each jurisdiction.
Crypto Regulation in the US
The U.S. is one of the largest and most influential markets in the world for cryptocurrencies, but also one of the most complex and fragmented in terms of regulation. Different federal agencies have different views and approaches to crypto regulation, creating uncertainty and confusion for market participants.
For example:
The U.S. Securities and Exchange Commission considers most cryptocurrencies as securities that fall under its jurisdiction and require registration and compliance with securities laws.
The U.S. Commodity Futures Trading Commission regards cryptocurrencies as commodities that can be traded on futures and derivatives markets.
The Internal Revenue Service treats cryptocurrencies as property that is subject to taxation.
The Department of the Treasury/Financial Crimes Enforcement Network applies anti-money laundering and counter-terrorism financing rules to crypto transactions.
The Office of the Comptroller of the Currency grants national bank charters to crypto companies that offer custody and payment services.
In addition to federal regulators, state regulators also have their own rules and requirements for crypto businesses operating within their jurisdictions. For example, New York has a BitLicense regime that imposes strict licensing and reporting obligations on crypto companies. On the flip side, Wyoming has enacted a series of laws that create a favorable environment for crypto businesses, such as exempting them from state taxes and recognizing them as legal entities.
The lack of a clear and consistent regulatory framework at the federal level has led some lawmakers to call for Congress' intervention to create comprehensive legislation that would harmonize and streamline crypto regulation across the U.S. In May 2023, President Biden signed an Executive Order on Ensuring Responsible Development of Digital Assets, which aims to foster research, collaboration, and coordination among federal agencies and stakeholders on crypto-related issues. The failure of U.S. Congress to provide federal leadership and direction has left a void that is being filled by aggressive regulators such as SEC Chairman Gary Gensler and the SEC as a whole.
Crypto Regulation in the EU
Currently, crypto regulation in the EU is largely based on national laws that differ across member states. Some countries, such as France, Germany, and Malta, have adopted specific laws or guidelines to regulate crypto activities, while others, such as Spain, Italy, and Ireland, have not.
However, this situation is expected to change with the introduction of the Markets in Crypto Assets (“MiCA”) regulation, which was proposed by the European Commission in September 2022 as part of its Digital Finance Package. MiCA aims to create a common set of rules for crypto-assets across the EU, covering aspects such as issuance, trading, custody, disclosure, and supervision. MiCA would also introduce a regulatory regime for stablecoins, which are cryptocurrencies that are pegged to fiat currencies or other assets to reduce volatility. MiCA would apply to both existing and new crypto-assets that are not already covered by other EU financial regulations.
MiCA is seen as a positive step towards creating a level playing field and enhancing legal certainty for crypto businesses and consumers in the EU. However, MiCA also faces some challenges and criticisms from stakeholders who argue that it could stifle innovation or create barriers to entry for smaller players. MiCA is still under negotiation among EU institutions and member states and is expected to be finalized by 2024.
The EU just completed its final rules under MiCA, which will take effect in 2024. Now that the crypto industry has clear rules of the road, the path to profitability and sustainability will focus on the world's third largest economy (the EU) and not its two largest (the U.S. and the UK).
Besides the U.S. and the EU, other regions also have different approaches and perspectives on crypto regulation. For example:
China has taken a hostile stance towards cryptocurrencies, banning initial coin offerings, crypto exchanges, and mining activities since 2017. China has also cracked down on peer-to-peer trading platforms and over-the-counter desks that facilitate crypto transactions. China's main motivation for restricting crypto activities is to maintain its monetary sovereignty and prevent capital flight. In other words, it’s about centralized control.
India has also shown a negative attitude towards cryptocurrencies, proposing a bill that would ban all private cryptocurrencies except for those issued by the central bank. India's main concerns are related to financial stability, consumer protection, and national security.
Japan has taken a proactive approach towards cryptocurrencies, recognizing them as legal tender since 2017. Japan has also established a licensing system for crypto exchanges and a self-regulatory organization for the industry. Japan's main goal is to promote innovation and competitiveness in the crypto space.
Singapore has adopted a balanced approach towards cryptocurrencies, regulating them under its Payment Services Act since 2020. Singapore requires crypto service providers to obtain licenses from the Monetary Authority of Singapore and comply with AML/CTF rules. Singapore's main objective is to foster a conducive environment for fintech development while mitigating risks.
Switzerland has taken a friendly approach towards cryptocurrencies, creating a Crypto Valley hub in Zug that attracts many crypto startups and investors. Switzerland has also issued clear guidelines on how to classify and tax different types of crypto assets. Switzerland's main vision is to become a global leader in blockchain technology.
If global regulation of cryptocurrencies remains fractured, then entrepreneurs will seek friendly jurisdictions that will promote innovation and capital formation. For crypto to truly thrive, it needs to be more coordination and cooperation among regulators at both regional and global levels to create a consistent and harmonized set of standards for cryptocurrencies.
